Sales Incentives: The impact on the bottom line

The paper is written by Ian Larkin of Harvard Business School, to be published in the Journal of Labor Economics. In his introduction, Assistant Professor Larkin explains the goal of his research: “It is well-known that employees “game” incentive systems by taking actions that increase their pay but hurt the objectives of their employer…… This “timing gaming” can affect business outcomes by changing revenue flow, pricing, or other key variables in ways beneficial to the employee but detrimental to the firm.While the prevalence of “timing gaming” is well-known, little is known about the scope or cost of this gaming to employers”.

This hypothesis in – in my experience – certainly correct. Any one involve din contracting – buy-side or sell-side – is well aware of the quarter-end banana curve and the year -end flurry in sales, driven by bonus schemes and incentives. Indeed, many buyers quite deliberately defer purchases and ensure that they sign only at the last minute, to extract maximum savings.

So what is the scale of the distortions that are created by today’s sales incentive schemes? Professor Larkin discovered that “salespeople agree to significantly lower pricing in quarters where they have a financial incentive to close a deal, resulting in mispricing that costs the vendor 6-8% of revenue”. He concludes that “salespeople with strong financial incentives to close a deal in a given quarter appear to grant discounts that are larger than necessary to win the deal in order to guarantee that the deal closes on the salesperson’s preferred timeline”. Indeed, I would suggest that this finding significantly understates the full cost. From IACCM research, we know that the weighting of business to quarter end creates massive inefficiencies in workload and puts tremendous stress upon processes and other areas of compliance and contract quality. I suspect that if we looked at downstream error rates, claims or disputes, many would tie back to the non-standard agreements and panic deals that are struck in those final few days of the quarter.

This topic certainly merits further investigation. What is unclear to me is whether businesses can really extract themselves from this game. Their customers now expect it. And indeed, I suspect that senior management in the supplier community is well aware of what is happening – so perhaps they have already elevated prices to take account of this perverse approach.

In a world where discounts and savings seem so fundamental to perceptions of value, ‘gaming’ of this sort is in many ways just a sort of bluff and double-bluff. But Professor Larkin’s work should cause any commercial expert to pause for thought and ask ‘Is there a better way?’